The Sydney Morning Herald's Economics Editor

FOR almost as long as big business has been crusading for a lower rate of company tax, I've been puzzling over its motives. Why are these people fighting for something of little or no benefit to their domestic shareholders and likely to be quite unpopular?

The willingness with which our economic establishment has gone along with the calls for lower company taxes is one of the great mysteries of 2012. Now the Organisation for Economic Co-operation and Development has signed up as an urger in its latest report on Australia.

But as David Richardson demonstrated on Saturday in his technical brief for the Australia Institute, claims that a lower rate of company tax would lead to more investment, faster economic growth and higher employment are surprisingly weak when you bother to examine them.

The puzzle doesn't end there, however. If lower company tax was of benefit to shareholders, it wouldn't be surprising to see big business arguing for it, even if it was of little or no benefit to the wider economy. But even this motivation doesn't hold.

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The push for lower company tax is enthusiastically pursued in the United States, and this wouldn't be the first reform push we'd imported holus-bolus from there. Just one small problem: we have a full dividend imputation system that America doesn't.

It wouldn't be all that surprising if many economists - and many punters - weren't quite on top of how dividend imputation affects the push for a lower company tax rate.

It would be amazing, however, if our chief executives didn't understand it. You'd also expect a lot of investment professionals to know the score.

The point is simply stated: when the rate of company tax is 30 per cent, the recipients of ''fully franked'' dividends are entitled to a refundable tax credit worth 30 per cent of the ''grossed-up'' value of the dividend.

So if your marginal tax rate is 46.5 per cent, the extra income tax you have to pay on your grossed-up dividend falls to a net 16.5 per cent. In this way the double taxation of dividends is eliminated.

Now let's say the big business lobby succeeds in persuading the government to cut the company tax rate to 25 per cent. With an unchanged dividend, the refundable tax credit falls to 25 per cent and the remaining tax to be paid rises to 21.5 per cent.

Only if companies were to respond to the lower company tax rate by increasing their dividend payouts sufficiently would domestic shareholders not see themselves as having been made worse off.

The introduction of dividend imputation led to a reduction in listed companies' efforts to minimise their company tax because Australian investors much prefer to hold the shares of companies paying enough tax to allow them to fully frank their dividends. Companies unable to deliver fully franked dividends can expect their share price to be marked down accordingly.

This is particularly true of Australian super funds, which are able to use imputation credits to largely extinguish the 15 per cent tax they pay on their annual investment earnings. (This tax quirk probably explains why our super funds are overinvested in shares and underinvested in fixed-interest.)

When you remember the way our chief executives bang on endlessly about shareholder value being their sole and sacred objective, you can only wonder why they pursue a cut in the company tax rate so fervently.

They're always distributing league tables showing our 30 per cent company tax rate as the equal-seventh highest among the 34 countries in the OECD. They never point to tables showing the combined effect of the company tax rate and the top personal tax rate. If they looked at it from this, domestic shareholders' perspective we'd fall to being just the 15th highest, with the US and Britain well above us.

For a long time I wondered whether the Business Council - many of whose members are largely foreign-owned - was championing the interests of foreign shareholders rather than locals.

It's true many foreign shareholders in Australian companies would benefit from a lower company tax rate because they're not eligible for imputation credits. One of the main reasons for the continued existence of company tax is to ensure the foreign owners of Australian businesses pay their fair share of Australian tax.

But not even all foreign shareholders would benefit from lower company tax. Americans (who account for more than a quarter of the stock of foreign investment in Australia) would gain nothing because the company tax rate they pay when they bring dividends home is already higher than our 30 per cent (for which they get a deduction). They wouldn't gain, but our Treasury would lose.

So what is big business on about? In his paper, Richardson argues it's a case of company executives pursuing their own interests, not those of the shareholders they profess to serve. (Economists call this a principal-and-agent problem.)

A lower rate of company tax would make companies' after-tax profits bigger, thus making their chief executives look more successful and probably leading to an increase in their remuneration.

It would also allow companies to retain and reinvest more after-tax earnings. This would make their companies bigger - which would probably also justify bosses being paid higher remuneration.

We already know chief executives play such self-seeking games because of all the mergers and takeovers, which rarely leave shareholders better off, but invariably leave the instigating chief executive more highly paid.

62 comments

I agree with the title but I think lower company tax definitely benefit economy way more than it benefits executives.

Paying less tax means more money for the companies and their shareholders and more money to be re-invested. It does make Australia an attractive place to invest.

Think of the other way, let's say we raise company tax to 100% and do you think any body would invest in Australia ever again?

Commenter

Joseph

Location

Sydney

Date and time

December 17, 2012, 9:25AM

Too simplistic, Joseph. The problem with tax rates is no one knows what the optimal rate is - you only know when it isn't by when you change the rate and tax recepits fall, and even then you have to take account the entire tax structure and foreign ones as well, plus the economy. Arguing for lower rates based by 100% being absurd is the same as arguing for higher rates as 0% is absurd.

The best way to reduce the principle-agent problem is to ensure executive board members are in the minority on the board, so they can't just vote themselves pay rises. We all know that the game of management is to make yourself more important and thus more valuable, and empire building is the simplest method. It becomes obvious, that not only for money but career, that this is the game. It's up to the owners to align the interests of the management with that of the owners, but it isn't easy.

Commenter

Twodogs

Location

Reality

Date and time

December 17, 2012, 11:15AM

Ok, put it another way - if we lowered company tax to zero, who would provide the infrastructure, who would educate and skill the workforce etc.

Commenter

Ross

Location

MALLABULA

Date and time

December 17, 2012, 11:25AM

Joseph, you've completely missed the article. You say that the tax saved would be reinvested, but there's behavioural evidence that it simply gets syphoned off by executives in the form of higher pay and benefits. I've worked for large corporates for most of my life and I can't disagree with that - nothing like directors and senior executives on the gravy train. As imputation credits mean that lower company tax does nothing for shareholders (Australian shareholders pay exactly the same amount of tax from their share dividends as it's treated as partly pre-taxed income), you have to ask what the motivation is.

Commenter

James from Brisbane

Location

Date and time

December 17, 2012, 12:46PM

The problem with given the wealthier in society more money is that it doesnt all get reinvested. It gets 'arranged' so that they pay less tax. we need to give more money to those less well off as they are not marginal consumers they are simply consumers; they will spend every extra dollar they get. we need to find where the propensity to consume becomes the marginal propensity to consume and start taxing more heavily AND reducing tax breaks for those who are marginal consumers

Commenter

Franky

Location

Sydney

Date and time

December 17, 2012, 12:57PM

@James from Brisbane, I thought of what said before I wrote the comment. Dividend imputation mean shareholder dividend is the same as before. But unless companies pay 100% profit as dividend part of the retained earning increased because of less tax.

What surprises me is that how could a smart guy like Ross miss that, or is he just biased?

Commenter

Joseph

Location

Sydney

Date and time

December 17, 2012, 9:43PM

@Twodogs and @Ross, this article is about whether tax cut would benefit shareholders and economy, not about benefit to tax collection.

I say it does. You guys honestly do not see that?

Commenter

Joseph

Location

Sydney

Date and time

December 17, 2012, 9:46PM

@Franky, nobody said ALL of the tax cut will be re-invested, but you have to agree some would. Wouldn't the extra investment benefit economy? Wouldn't the retained earning because of less tax benefit the companies and their shareholders?

I thought this is simple enough.

I think this article and the people agree to it is all about corporate hatred than sound logic.

Not all CEOs are greedy evil people (some probably are). Not all their sayings are self served.

Commenter

Joseph

Location

Sydney

Date and time

December 17, 2012, 9:53PM

Guys, if we are simply talking about whether company tax cut would benefit shareholders, then it is quite simple, it does.

If we increase company tax to 100% and that means no investors (shareholders) would invest in Australia. That would conclude company tax increase discourages investment. And that also means company tax cuts would benefit investors and shareholders.

Does it benefit executives? Yes, it does. If companies are more profitable it benefits their executives as well because it is easier for them to reach their performance targets, which increase the chances for them to get their bonuses. That is quite simple.

Does it benefit this country as a whole? Not sure, reduced tax revenue could cause problems to this country as a whole.

But please don't say company tax cuts do not benefit shareholders and only benefit executives, and company tax cuts means executives get paid more but shareholders receive no benefit at all. Come on! We are not 3 years old.

Commenter

Joseph

Location

Sydney

Date and time

December 17, 2012, 11:04PM

that's right lowering corporate tax rates won't make any difference to individuals that own shares.

So what does it make a difference to then? Corporate earnings retained for reinvestment. That's what its really taxing. In some ways it's the opposite of a consumption tax - its a tax on investment.

Surely we should be promoting investment? Lowering corporate income taxes is the best way to do so, and it won't lower the effective tax rates of any individuals.